The success of an incentive plan depends on the organizational climate in which it must operate, employee confidence in it, and its sustainability to employee and organizational needs. Importantly, employees must view their incentive pay as being equitable and related to their performance. Performance measures should be quantifiable, be easily understood, and bear a demonstrated relationship to organizational performance. It is said that an effective compensation and reward system is composed of three elements – financial rewards, non-financial rewards and psychological satisfactions. These components are important and it is required that these components are balanced. While, financial rewards are the most noticeable elements, relying on it as an incentive can do more harm than good.

One form of incentive system is merit pay, which is based on giving financial incentives. While this is seen by many as effective in improving performance, relying on financial incentives as an employee motivator can create problems. Merit pay works well when behaviors that contribute to the effective functioning of the firm are rewarded. Behaviors critical to organizational effectiveness include innovation, empowerment, and customer service. Behaviors rather than results are especially important to measure when the results are outside the control of employees. Merit pay plans have been criticized because they may promote an entitlement culture and because they fail to differentiate high and low performers The perception of merit pay systems is multidimensional, consisting of performance assessments and merit pay allocation. Another criticism of merit pay is that it leads to competition rather than cooperation. Employees are pitted against one another to compete for a limited fund. Paying for individual performance strikes some companies as too difficult.

Financial incentive schemes can also be a source of discontentment of employees, especially when they view that they are unfairly treated. Preconditions for merit pay – trust in management, a valid job evaluation system, clear performance factors, meaningful and consistent funding, and accurate personnel appraisal must be present. Even if these exists, merit pay compensation may perversely:

·Focus on short term at the expense of the long term

·Encourage mediocrity by setting limits on expectations

·Destroy teamwork because it increases dependence on individual accomplishment

Financial incentives are not always the key for motivated and high performing employees. Considering Maslow’s Hierarchy of Needs, we can see that money is just a part of physiological needs which is at the lowest level of the hierarchy. Maslow’s basic idea was simple: People will not be healthy and well adjusted unless they have their needs met. Specifically, Maslow (1954) proposed that all people seek to satisfy five basic kinds of needs: psychological needs, safety needs, belongingness needs, esteem needs, and self-actualization needs. Maslow suggested that these needs constitute a hierarchy of needs, with the most basic or compelling—physiological and safety needs—at the bottom. Maslow argued that these lowest-level needs must be met before a person will strive to satisfy needs higher up in the hierarchy, such as self-esteem needs. Once a need is satisfied, he proposed, it ceases to operate as a source of motivation. The lowest level of unmet needs in the hierarchy is the prime motivator of behavior; if and when this level is satisfied, needs at the next highest level in the hierarchy motivate behavior.

Some key conclusions that can be drawn from Maslow’s hierarchy are:

There are several aspects of the workplace other than money (to provide for physiological needs)

Since people can be at any of the levels of the hierarchy, what substantially motivates one person may provide only minimal motivation to another—thus managers must be aware of the needs of each individual

What motivates a person may change over time, thus the assessment of a person’s needs must be continuous.

McClelland’s Achievement Theory puts a premium on affiliation, power and achievement and not on money or financial rewards. David McClelland (1961) theorized that individuals have three basic motivational needs: affiliation, power, and achievement. The affiliation motive can be explained as a strong desire for individual and group approval, and it reflects the desire for social acceptance and friendship. The power motive can be satisfied by being in control. It is expressed as a strong desire to change events and to exercise influence over others. The achievement motive is based on the need to achieve and win. It is characterized by seeking a challenge, establishing goals, working hard, and succeeding. For managers, all three motives—affiliation, power, and achievement—are important when it comes to motivating employees. What is more, McClelland found that learning, education, and training can stimulate a greater need to achieve. Managers can use their understanding of the three needs to match employees to tasks that help them fulfill these needs, resulting in high performance. For example, it is wasteful to place a person with a high need for achievement in a job with routine demands. This person would not feel challenged, would probably become bored, lose interest, and perhaps leave the job. People with a high need for affiliation are likely to perform better in jobs with a lot of interpersonal contact, as well as personal support and approval tied to their performance (Sims 2002).